(Originally published as [US Dollar Hegemony has to go] in AToL on
April 11. 2002)

There is an
economics-textbook myth that foreign-exchange rates
are determined by supply and demand based on market fundamentals.
Economics tends to dismiss socio-political factors that shape market
fundamentals that affect supply and demand.

The current
international finance architecture is based on the
US dollar as the dominant reserve currency, which now accounts for 68
percent of global currency reserves, up from 51 percent a decade ago.
Yet in 2000, the US share of global exports (US$781.1 billon out of a
world total of $6.2 trillion) was only 12.3 percent and its share of
global imports ($1.257 trillion out of a world total of $6.65 trillion)
was 18.9 percent. World merchandise exports per capita amounted to
$1,094 in 2000, while 30 percent of the world's population lived on
less than $1 a day, about one-third of per capita export value.

Ever since 1971,
when US president Richard Nixon took the
dollar off the gold standard (at $35 per ounce) that had been agreed to
at the Bretton Woods Conference at the end of World War II, the dollar
has been a global monetary instrument that the United States, and only
the United States, can produce by fiat. The dollar, now a fiat
currency, is at a 16-year trade-weighted high despite record US
current-account deficits and the status of the US as the leading debtor
nation. The US national debt as of April 4 was $6.021 trillion against
a gross domestic product (GDP) of $9 trillion.

World trade is now a
game in which the US produces dollars and
the rest of the world produces things that dollars can buy. The world's
interlinked economies no longer trade to capture a comparative
advantage; they compete in exports to capture needed dollars to service
dollar-denominated foreign debts and to accumulate dollar reserves to
sustain the exchange value of their domestic currencies. To prevent
speculative and manipulative attacks on their currencies, the world's
central banks must acquire and hold dollar reserves in corresponding
amounts to their currencies in circulation. The higher the market
pressure to devalue a particular currency, the more dollar reserves its
central bank must hold. This creates a built-in support for a strong
dollar that in turn forces the world's central banks to acquire and
hold more dollar reserves, making it stronger. This phenomenon is known
as dollar hegemony, which is created by the geopolitically constructed
peculiarity that critical commodities, most notably oil, are
denominated in dollars. Everyone accepts dollars because dollars can
buy oil. The recycling of petro-dollars is the price the US has
extracted from oil-producing countries for US tolerance of the
oil-exporting cartel since 1973.

By definition,
dollar reserves must be invested in US assets,
creating a capital-accounts surplus for the US economy. Even after a
year of sharp correction, US stock valuation is still at a 25-year high
and trading at a 56 percent premium compared with emerging markets.

The Quantity Theory
of Money is clearly at work. US assets are
not growing at a pace on par with the growth of the quantity of
dollars. US companies still respresent 56 percent of global market
capitalization despite recent retrenchment in which entire sectors
suffered some 80 percent a fall in value. The cumulative return of the
Dow Jones Industrial Average (DJIA) from 1990 through 2001 was 281
percent, while the Morgan Stanley Capital International (MSCI)
developed-country index posted a return of only 12.4 percent even
without counting Japan. The MSCI emerging-market index posted a mere
7.7 percent return. The US capital-account surplus in turn finances the
US trade deficit. Moreover, any asset, regardless of location, that is
denominated in dollars is a US asset in essence. When oil is
denominated in dollars through US state action and the dollar is a fiat
currency, the US essentially owns the world's oil for free. And the
more the US prints greenbacks, the higher the price of US assets will
rise. Thus a strong-dollar policy gives the US a double win.

Historically, the
processes of globalization has always been
the result of state action, as opposed to the mere surrender of state
sovereignty to market forces. Currency monopoly of course is the most
fundamental trade restraint by one single government. Adam Smith
published Wealth
of Nations
in 1776, the year of US independence. By the time the constitution was
framed 11 years later, the US founding fathers were deeply influenced
by Smith's ideas, which constituted a reasoned abhorrence of trade
monopoly and government policy in restricting trade. What Smith
abhorred most was a policy known as mercantilism, which was practiced
by all the major powers of the time. It is necessary to bear in mind
that Smith's notion of the limitation of government action was
exclusively related to mercantilist issues of trade restraint. Smith
never advocated government tolerance of trade restraint, whether by big
business monopolies or by other governments.

A central aim of
mercantilism was to ensure that a nation's
exports remained higher in value than its imports, the surplus in that
era being paid only in specie money (gold-backed as opposed to fiat
money). This trade surplus in gold permitted the surplus country, such
as England, to invest in more factories to manufacture more for export,
thus bringing home more gold. The importing regions, such as the
American colonies, not only found the gold reserves backing their
currency depleted, causing free-fall devaluation (not unlike that faced
today by many emerging-economy currencies), but also wanting in surplus
capital for building factories to produce for export. So despite
plentiful iron ore in America, only pig iron was exported to England in
return for English finished iron goods.

In 1795, when the
Americans began finally to wake up to their
disadvantaged trade relationship and began to raise European (mostly
French and Dutch) capital to start a manufacturing industry, England
decreed the Iron Act, forbidding the manufacture of iron goods in
America, which caused great dissatisfaction among the prospering
colonials. Smith favored an opposite government policy toward promoting
domestic economic production and free foreign trade, a policy that came
to be known as "laissez faire" (because the English, having nothing to
do with such heretical ideas, refuse to give it an English name).
Laissez faire, notwithstanding its literal meaning of "leave alone",
meant nothing of the sort. It meant an activist government policy to
counteract mercantilism. Neo-liberal free-market economists are just
bad historians, among their other defective characteristics, when they
propagandize "laissez faire" as no government interference in trade
affairs.

A strong-dollar
policy is in the US national interest because
it keeps US inflation low through low-cost imports and it makes US
assets expensive for foreign investors. This arrangement, which Federal
Reserve Board chairman Alan Greenspan proudly calls US financial
hegemony in congressional testimony, has kept the US economy booming in
the face of recurrent financial crises in the rest of the world. It has
distorted globalization into a "race to the bottom" process of
exploiting the lowest labor costs and the highest environmental abuse
worldwide to produce items and produce for export to US markets in a
quest for the almighty dollar, which has not been backed by gold since
1971, nor by economic fundamentals for more than a decade. The adverse
effect of this type of globalization on the developing economies are
obvious. It robs them of the meager fruits of their exports and keeps
their domestic economies starved for capital, as all surplus dollars
must be reinvested in US treasuries to prevent the collapse of their
own domestic currencies.

The adverse effect
of this type of globalization on the US
economy is also becoming clear. In order to act as consumer of last
resort for the whole world, the US economy has been pushed into a debt
bubble that thrives on conspicuous consumption and fraudulent
accounting. The unsustainable and irrational rise of US equity prices,
unsupported by revenue or profit, had merely been a devaluation of the
dollar. Ironically, the current fall in US equity prices reflects a
trend to an even stronger dollar, as it can buy more deflated shares.

The world economy,
through technological progress and
non-regulated markets, has entered a stage of overcapacity in which the
management of aggregate demand is the obvious solution. Yet we have a
situation in which the people producing the goods cannot afford to buy
them and the people receiving the profit from goods production cannot
consume more of these goods. The size of the US market, large as it is,
is insufficient to absorb the continuous growth of the world's new
productive power. For the world economy to grow, the whole population
of the world needs to be allowed to participate with its fair share of
consumption. Yet economic and monetary policy makers continue to view
full employment and rising fair wages as the direct cause of inflation,
which is deemed a threat to sound money.

The Keynesian
starting point is that full employment is the
basis of good economics. It is through full employment at fair wages
that all other economic inefficiencies can best be handled, through an
accommodating monetary policy. Say's Law (supply creates its own
demand) turns this principle upside down with its bias toward
supply/production. Monetarists in support of Say's Law thus develop a
phobia against inflation, claiming unemployment to be a necessary tool
for fighting inflation and that in the long run, sound money produces
the highest possible employment level. They call that level a "natural"
rate of unemployment, the technical term being NAIRU (non-accelerating
inflation rate of unemployment).

It is hard to see
how sound money can ever lead to full
employment when unemployment is necessary to maintain sound money.
Within limits and within reason, unemployment hurts people and
inflation hurts money. And if money exists to serve people, then the
choice becomes obvious. Without global full employment, the theory of
comparative advantage in world trade is merely Say's Law
internationalized.

No single economy
can profit for long at the expense of the
rest of an interdependent world. There is an urgent need to restructure
the global finance architecture to return to exchange rates based on
purchasing-power parity, and to reorient the world trading system
toward true comparative advantage based on global full employment with
rising wages and living standards. The key starting point is to focus
on the hegemony of the dollar.

To save the world
from the path of impending disaster, we must:

# promote an awareness among policy makers globally that
excessive
dependence on exports merely to service dollar debt is self-destructive
to any economy;

# promote a new global finance architecture
away from a dollar hegemony that forces the world to export not only
goods but also dollar earnings from trade to the US;

# promote the application of the State Theory of Money (which asserts
that the value of money is ultimately backed by a government's
authority to levy taxes) to provide needed domestic credit for sound
economic development and to free developing economies from the tyranny
of dependence on foreign capital;

# restructure
international economic relations toward aggregate demand management
away from the current overemphasis on predatory supply expansion
through redundant competition; and restructure world
trade toward true comparative advantage in the context of global full
employment and global wage and environmental standards.

This is easier done than imagained. The starting point is for
the major exporting nations each to unilaterally require that all its
exports be payable only in its currency, so that the global finance
architecture will turn into a multi-currency regime overnight. There
would be no need for reserve currencies and exchange rates would
reflect market fundamentals of world trade.

As for aggregate demand management, Asia leads the world in
both overcapacity and underconsumption. It is high time for Asia to
realize the potential of its market power. If the people of Asia are to
be compensated fairly for their labor, the global economy will see its
fastest growth ever.